Loan Origination Fees – More Painful than Interest

Getting a loan is undoubtedly a great way to meet short term needs. Whether you’re looking to consolidate debts, partake in home improvement projects, or pay for unexpected expenses, a personal loan can help you achieve your goals.

Personal loans, like any credit product, come with costs.. The most obvious cost of the loan is the interest rate charged to the borrower. These interest rates are incurred over the life of the loan and are charged against the amount you borrowed. However, one of the more obscure costs that you might incur are Origination Fees.

What are Origination Fees?

An Origination Fee, at its core, is simple to understand but many people don’t. Some lenders call it a service fee, commission fee, closing fee, or even a setup fee. Whatever you decide to call it, it’s a fee that the lender charges the borrower for “originating”, or issuing, the loan. Here’s a simplistic way to think about origination fees:

You are getting a personal loan for $10,000 at a 20% interest rate for three years. At the end of the application, you find there is an Origination Fee of 5%.

As soon as you sign the dotted line to finalize the loan agreement, the lender is automatically charging a 5% Origination Fee. So instead of the $10,000 that you thought you were borrowing, you’re only receiving $9,500.

But guess what? You still pay interest on the full $10,000 AND when you pay the lender back, you still owe them $10,000 PLUS interest. Sounds a little unfair, no? Paying 5% sounds like a small number, but think about what you’d be able to do with that extra $500 in your pocket.

What’s the Big Deal with Origination Fees?

So now that we know what origination fees are and how much some lenders charge, the real question is – Why should you care?.

Two reasons:

As mentioned above, if you apply for a $10,000 loan, you won’t get that full amount. If you qualify for a $10,000 loan (with a 5% origination fee) to pay for that home improvement project, you’ll only get $9,500 that you can use. Here’s a quick example of how origination fees can impact your loan.

If you intend to pay back the loan before the full term, that $500 origination fee you paid will still have to be paid back. Lenders may advertise that they don’t have any prepayment penalties, but these origination fees essentially act as a prepayment penalty in disguise.

Depending on how fast you expect to pay off the loan, the true cost of the loan will vary. If you look at the chart below, it assumes you pay a 5% origination fee. It illustrates a $10,000 loan for 36 months that with a 5% origination fee. Here’s how to read it:

If you intend to pay back a loan within 6 months with an interest rate of 25%, you’re better off getting a loan that has an APR of up to 33.11% without origination fees.

If you intend to pay back the loan within 12 months with an interest rate of 20%, you’re better off getting a loan that has an APR of of up to 22.91% without origination fees.

So what type of fees are lenders charging?

The fees that lenders charge varies. Some go by the “grade” of the loan (how qualified you are) and others may charge you an origination fee based on your loan amount.

Lending Club: Lending Club charges anywhere from 1-6% in origination fees depending on your credit-worthiness. You’ll need to be a super-prime borrower – basically a pristine credit score and a really low debt-to-income ratio. In 2016, only 17% of borrowers qualified for an “A” grading and even if you qualify for this grade, you’re not even guaranteed the lowest origination fee.

Prosper: You’ll notice a very similar pattern with Prosper as well. In order to be charged a 1-6% “closing fee” (aka origination fee), you’ll need to be a super-prime borrower. Otherwise, you’ll be charged at least 3.95% in origination fees, see chart below.

Are Origination Fees Prepayment Penalties in Disguise?

Let’s do a quick recap of origination fees on personal loans and how it affects your loan.

You’re approved for a $10,000 loan with a 5% origination fee

You actually receive $9,500 ($500 in origination fees).

Your loan balance is still $10,000

You continue to pay interest on the $10,000 loan amount when you only technically receive $9,500.

What happens if you decide to pay off the loan in the next week? Or even the next day. You’re not entitled to any refund on the origination fee you just paid. So the origination fee is disguised like a prepayment penalty.

To say that origination fees are the same as pre-payment fees is technically incorrect. However, these origination fees are embedded into the loan to ACT like a prepayment fee. If you ever decide to pay off the loan in full in advance, the only person who really benefits from this is the lender. You, as the borrower, are getting the short end of the stick.

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